Best's Special Report: Insurers Exceed Cost of Capital Across Segments, Despite Varying Challenges

Despite another year of elevated catastrophe losses, U.S. property/casualty (P/C) insurers generated high investment returns and were able to exceed their cost of capital in 2024, according to new AM Best report.

Both life/annuity and health insurers navigated separate challenges within their respective segments and were also able to exceed the cost of capital. The cost of capital provides a measure of how much in returns investors can expect to generate for an investment. It considers the cost of debt and cost of equity, with weights relative to an individual company’s dependence on each method of raising capital, as well a risk factor based on the company’s risk profile.

Despite experiencing two major hurricanes, severe convective storms and winter weather events in 2024, the P/C industry recorded an underwriting gain of approximately $22.9 billion. This marked a significant improvement over a $21.3 billion underwriting loss in 2023. “P/C insurers have been able to reinvest bonds at higher interest rates, and their diversified equity portfolios also boosted investment income materially,” said Helen Andersen, industry analyst, AM Best. “This segment is estimated to have increased investment income by 15% in 2024.”

Health insurers have consistently exceeded their cost of capital over the past 15 years. The median return on capital employed (ROCE) in this segment has steadily decreased over the past four years, yet still surpassed the median weighted average cost of capital (WACC) by about 2.5 percentage points, according to the Best’s Special Report. The decline in health insurers’ returns has been driven by rising medical and pharmaceutical costs, in conjunction with higher claims.

As a very long-tailed line, the L/A segment is heavily reliant on investments to generate operating returns and is significantly impacted by interest rates. According to the report, the L/A segment’s return on equity outperformed its cost of equity capital by close to 8 percentage points – the strongest outperformance over the past 15 years, driven by rising interest rates as U.S. consumers were attracted to the rates offered by annuity products. Insurers with such strong performance and robust capital positions have an implied reduced risk of default, potentially driving down the cost of debt and making equity financing less expensive.

Unlike the health and P/C segments, the median WACC for L/A writers did not decline in 2024, despite a similar decrease in cost of equity. The report also notes that life insurers are more reliant on debt financing, so the decrease in cost of equity had less effect. In general, life insurers are more asset-intensive, so their cost of equity is more correlated with equity market volatility.

To access a copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=353403.

AM Best is a global credit rating agency, news publisher and data analytics provider specialising in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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